Chapter 10 Homework (from end of chapter problems) TO HELP UNDERSTAND #6, USE THE TABLES BELOW AS A GUIDE First, for part A, fill in the table below then graph a budget line. Second, for part B, fill in the table below. Utility Marginal Quantity Marginal Utility from from utility Quantity of of utility CDs notebooks per dollar CDs notebooks notebooks (utils) (utils) notebooks 0 0 0 0 2 70 1 80 4 130 2 150 6 180 3 210 8 220 4 260 10 250 5 300 Marginal utility CDs Marginal utility per dollar CDs Third, graph the data as instructed in part C. You will be able to tell the correct bundle by looking at total utility from bundle in the first table (check your work this way). Chapter 10 The Rational Consumer 1 Chapter 10  A model of how consumers decide on a “consumption bundle” that is optimal  Utility and Consumer Behavior 2 Utility  Utility – a measure of satisfaction a consumer derives from consumption of goods and services  Consumption Bundle – the collection of all goods and services consumed by that individual  Utility Function – describes the relation between an individual’s consumption bundle and utility 3 Utility Function 4 Graphical Utility Function 5 Marginal Utility Curve 6 Diminishing Marginal Utility  According to the principle of diminishing marginal utility, each successive unit of a good or service consumed adds less to total utility than the previous unit.  One of the reasons for a downward sloping demand curve  You can see it in the marginal utility graph (last slide) 7 Optimal Choice and MU  If an individual is not constrained by budget, then maximum utility is achieved when an individual consumes until marginal utility is no longer positive 8 Practice  Sergio consumes peanuts, fill in his marginal utility in the table below. Sketch total and marginal utility on a graph 9 Quantity of bags of Total utility for peanuts Sergio Marginal utility 0 0 --- 1 10 2 19 3 27 4 34 5 40 Practice  Sergio consumes peanuts, fill in his marginal utility in the table below. Graph total and marginal utility 10 Quantity of bags of Total utility for peanuts Sergio Marginal utility 0 0 --- 1 10 10 2 19 9 3 27 8 4 34 7 5 40 6 Budget Constraint  A budget constraint requires that the cost of a consumer’s consumption bundle be no more than the consumer’s income.  Our Example  Income = $20 per week  Price of clams = $4 per pound  Price of potatoes = $2 per pound  Expenditure on Clams + Expenditure on Potatoes ≤ Income 11 Budget Constraint  A consumer’s consumption possibilities is the set of all consumption bundles that can be consumed given the consumer’s income and prevailing prices. (the budget line + everything underneath)  A consumer’s budget line shows the consumption bundles available to a consumer who spends all of his or her income. 12 Graphical Budget Constraint 13 Optimal Choice  Considering both:  1. utility function  2. budget constraint  An individual maximizes their utility by choosing the consumption bundle with the highest utility that is affordable 14 Total Utility 15 Utility On The Budget Line 16 17 Practice  Sergio can consume bundles containing peanuts and Coke.  The price of peanuts is $2  The price of Coke is $1  Construct a budget line for Sergio with Quantity of Cokes on the horizontal axis  Sergio has $12 dollars of income 18 Practice 19 Practice 20 Marginal Utility Per Dollar  The marginal utility per dollar spent on a good or service is the additional utility from spending one more dollar on that good or service.  Calculate by dividing marginal utility by price  Marginal Utility Per Dollar = MU/P 21  f 22 Principle  According to the utility-maximizing principle of marginal analysis, the marginal utility per dollar spent must be the same for all goods and services in the optimal consumption bundle. 23 Principle 24 Practice  Fill in the table below. The price of peanuts is $2 25 Quantity of bags of peanuts Total utility for Sergio Marginal utility Marginal utility per dollar 0 0 --- --- 1 10 10 2 19 9 3 27 8 4 34 7 5 40 6 Practice  Fill in the table below. The price of peanuts is $2 26 Quantity of bags of peanuts Total utility for Sergio Marginal utility Marginal utility per dollar 0 0 --- --- 1 10 10 5 2 19 9 4.5 3 27 8 4 4 34 7 3.5 5 40 6 3 Practice  Determine how many of each good Sergio will buy and in which order. Coke is $1, peanuts $2, income =$12 27 Quantity of bags of peanuts Marginal utility per dollar (peanuts) Quantity of Cokes Marginal utility per dollar (Cokes) 0 0 0 0 1 5 1 8 2 4.5 2 6 3 4 3 4 4 3.5 4 3 5 3 5 2 Behind the Demand Curve  Three reasons for a downward sloping demand curve  Diminishing marginal utility  Substitution effect  Income effect  We assumed diminishing marginal utility earlier 28 Substitution Effect  Our rule for optimal choice  If price of clams rises then our principle would not hold, and the equality would occur at a higher level of potatoes and a lower level of clams  Sam would substitute away from clams  The substitution effect of a change in the price of a good is the change in the quantity of that good consumed as the consumer substitutes other goods that are now relatively cheaper in place of the good that has become relatively more expensive. 29 Income Effect  The income effect of a change in the price of a good is the change in the quantity of that good consumed that results from a change in the consumer’s purchasing power due to the change in the price of the good.  You can see this at work when the budget line pivots due to changing price 30 Chapter 10 in Class Practice Econ 112 #1 Sergio consumes peanuts, fill in his marginal utility in the table below. Sketch a total and marginal utility curve on a graph. #2 Sergio can consume peanuts and Coke™. The price of peanuts is $2, the price of Coke is $1. Construct a budget line for Sergio with the quantity of Coke on the horizontal axis. His income is $12. #3 fill in the table below. The price of peanuts is $2. #4 Determine how many of each good Sergio will buy and in which order. The price of Coke is $1, and peanuts are $2. Sergio’s income is $12.
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